Int. J.

Production Economics 81–82 (2003) 153–162

Retailer’s pricing, credit and inventory policies

for deteriorating items in response to temporary
price/credit incentives
F.J. Arcelusa,*, Nita H. Shahb, G. Srinivasana
a
Faculty of Administration, University of New Brunswick, P.O. Box 4400, Fredericton, N.B. E3B 5A3, Canada
b
Department of Mathematics and Statistics, Gujarat University, Ahmedabad 380009, Gujarat, India

Abstract

It is the purpose of this paper to model the retailer’s profit-maximizing retail promotion strategy, when confronted
with a vendor’s trade promotion offer of credit and/or price discount on the purchase of regular or perishable
merchandise. At issue is the determination of the three main elements of the retailer’s promotion strategy, namely (i) the
size of the special order to be placed from the vendor, under the different types of possible trade incentives offered;
(ii) the price and/or credit-terms incentives to be passed on to its own customers to stimulate demand on a temporary
basis; and (iii) the quantity to be sold under these one-time-only conditions.
r 2002 Elsevier Science B.V. All rights reserved.

Keywords: Inventory; Special sales; Promotion incentives; Marketing/inventory interface

1. Introduction items purchased or, at the very least, with a much

Fear of retaliation from stronger competitors to
temporary price changes designed to stimulate
demand often leads vendors to search for alternate
financial incentives to be used as substitutes or in
conjunction with price discounts. A trade promo-
tion policy that lessens the chance of attracting
such competitive retaliation, at least in the short-
run, contemplates suppliers offering credit to their
retailers. This lengthens temporarily their repay-
ment cycle without reducing the price paid for the
*Corresponding author. Tel.: +1-506-453-4869; fax: +1-
506-453-3561.
E-mail addresses: arcelus@unb.ca (F.J. Arcelus), srini@
unb.ca (G. Srinivasan).
reduced price discount offered (e.g. Blattberg and
Neslin, 1990). A retailer, in turn, can induce
increases in the demand for its own products
among its own customer base, without necessarily
having to encompass the vendor’s entire trade
offer. The marketing evidence is clear on this
point. Profit-maximizing retailers seldom pass on
all incentives to its customers (e.g. Ailawadi and
Farris, 1999; Blattberg et al., 1995; Kim and
Staelin, 1999), nor do they have to incorporate in
their retail promotions all the units included in the
vendor’s special offer (e.g. Arcelus and Srinivasan,
1998). This ability to alter demand is specially
salient in the case of perishable items, for which
direct spoilage, physical depletion or deterioration
over time shorten substantially the life expectancy

0925-5273/02/$ - see front matter r 2002 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 5 - 5 2 7 3 ( 0 2 ) 0 0 2 6 9 - 4
154 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
of these items and, with it, their time span of
profitability.
It is the purpose of this paper to model the
retailer’s profit-maximizing retail promotion strat-
egy, when confronted with a vendor’s trade
promotion of credit and/or price discount on the
purchase of regular or perishable merchandise. It
is assumed that there already exists a regular
credit/price policy between the retailer and the
vendor, for which the retailer has already devel-
oped a profit-maximizing strategy. At issue in this
paper is the determination of the three main
elements of the retailer’s promotion strategy, in
response the vendor’s special one-time-only trade
promotion, namely (i) the size of the special order
to be placed from the vendor, under the different
types of possible trade incentives offered; (ii) the
portions of the benefits to be passed on to its own
customers, in the form of new price and/or credit-
terms incentives intended to stimulate demand on
a temporary basis; and (iii) the quantity to be sold
under these one-time-only conditions.
Until recently, the inventory literature has paid
scant notice to these marketing trends in the
modelling of the special-sale problem, since most
of the articles assume a constant demand. In fact,
not even a joint price/credit retailer regular policy
in the absence of any incentives has been studied
so far. Baker (1976) sets the stage for the modern
formulations, with its deterministic, cost-minimiz-
ing, constant-demand model, which appears in
most textbooks on the subject (e.g. Silver et al.,
1998; Tersine, 1994). Only in the last few years, an
attempt has been made to reverse this trend.
Arcelus and Srinivasan (1998) summarize most of
this literature. Key articles for the purposes of this
paper include: (i) Lev and Weiss (1990), with its
simultaneous multi-parameter changes and the
development of finite horizon ordering policies;
(ii) Luciano and Peccati (1999), with its adjusted-
present-value approach; and (iii) Abad (1997),
Arcelus and Srinivasan (1998) and Ardalan (1991),
with their price-dependent demand, thus opening
the way for the study of the optimal proportion of
trade discount to be passed on to the retailer’s own
customers. The one-time-only credit literature,
with its constant-demand assumption (e.g. Arcelus
and Srinivasan, 1993), has largely ignored these
trends. Promising efforts in the direction of
updating this model include the recent works of
Chu et al. (1998), Hwang and Shinn (1997) and
Shinn (1997). A similar statement may be made
with respect to the literature on perishable items.
Here, cost-minimization models, with time-depen-
dent rather than price-induced demand, are the
rule. As a result, the effect of perishability on
demand and especially on the retailer’s reaction to
speed-up sales, so as to mitigate the effect of the
larger order’s deterioration loss through tempor-
ary price and/or credit incentives, is ignored.
Nahmias (1982), for the fixed-life perishable
inventory problem and Raafat (1991), for con-
tinuously deteriorating models, survey this litera-
ture. Only recently have perishable models begun
to treat some more modern concerns. Of direct
relevance to the current paper are (i) Shah and
Shah (1993), on the effect of temporary price
discounts, but with constant demand; and (ii) Chu
et al. (1998) and Hwang and Shinn (1997), on the
effect of permissible delay of payments, with price-
dependent demand.
On the basis of these caveats related to the
existing literature, the paper is organized as
follows. Section 2 discusses the retailer’s strategic
decision as it applies to the case of non-perishable
items. Joint credit/discount retailer strategies will
be derived to handle regular and special incentive
vendor–retailer interactions, neither of which has
been treated in the literature so far. The issue of
perishability is addressed in Section 3. As will be
shown shortly, the need for two separate models
strives from the fact that the item–item model is
not a trivial special case of its perishable counter-
part, due to the special nature of the differential
equations giving rise to the respective expressions
for the inventory rate per unit of time. Special
emphasis will be given to the managerial implica-
tions of the optimality conditions, which are fully
in accord with the tenets of economic theory.
Section 4 completes the paper.
2. The non-perishable case
The basic characteristics of this case are
summarized in Table 1. The remainder of this
 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162 155

Table 1
The retailer’s inflows, outflows and benefits for the non-perishable case

The retailer RECEIVES regular (for s ¼ 0) credit of g0 or a special offer (for s ¼ 1; 2; 3) of a price of c1 oc0 and a credit of g1 > g0
Outflows per cycle for s ¼ 0 O0 ¼ c0 Q0 þ K þ c0 iQ0 Z0 ð1  g0 Þ
Outflows per cycle for Scenario s ¼ 1; 2; 3 Os ¼ c1 Qs þ K þ c1 iQs Zs ð1  g1 Þ;
with Zs ¼ the depletion time for s

The retailer OFFERS (per cycle)

Scenario(s) ðps ts Þ Zs Inflows, Is Decision var

Regular period ðp0 t0 Þ Q0 =R0 p0 Q0 þ p0 rQ0 Z0 ð1  t0 Þ=2 p0 Q0 t0

Special credit & price ðp1 t1 Þ ðQ1  q1 Þ=R1 þ q1 =R0 p1 ðQ1  q1 Þ þ p0 q1 p1 Q1 q1 t1
þ p1 rðQ1  q1 Þ2 ð1  t1 Þ=ð2R1 Þ
þ p0 rq21 ð1  t0 Þ=ð2R0 Þ

Special price only ðp1 t0 Þ ðQ1  q1 Þ=R1 þ q1 =R0 p1 ðQ1  q1 Þ þ p0 q1 þ p1 rðQ1  q1 Þ2 ð1  t0 Þ=ð2R1 Þ p1 Q1 q1
þ p0 rq21 ð1  t0 Þ=ð2R0 Þ

Special credit only ðp0 t1 Þ Q1 =R1 p0 Q1 þ p0 rðQ1  q1 Þ2 ð1  t1 Þ=ð2R1 Þ Q1 t1 q1

þ p0 rq21 ð1  t0 Þ=ð2R0 Þ

section is devoted to an explanation of this table.
The modelling process starts by describing the
basic properties of the vendor/buyer/consumer
interaction. This is followed by a detailed devel-
opment of the retailer’s decision process and of the
optimality conditions.
2.1. Common properties
Regardless of whether a particular price/credit
offer is regular or special, the vendor/buyer/
consumer interaction exhibits some common
properties embedded in the price/credit offers
made by the vendor to the retailer and by the
retailer to the consumer or ultimate customer.
Hence, both types are defined at the same time,
with the regular (special) offer identified by
scenario s ¼ 0 (s ¼ 1). A vendor’s offer to the
retailer and a retailer’s offer to its own customers
are defined in the first two properties
Property 2.1. A vendor’s offer to the retailer is
characterized by a pair of values of ðcs ; gs Þ, s ¼ 0; 1,
corresponding to a unit cost of cs , c1 pc0 , and a
purchasing credit period, defined by a payment
delay of length gs , g1 Xg0 X0:
Property 2.2. A retailer’s offer to its own customers
is characterized by a pair of values of ðps ; ts Þ,
s ¼ 0; 1, corresponding to a unit selling price of ps ,
p1p p0 and a selling credit period of length ts ,
t1 Xt0 X0:
Property 2.2 identifies the two extreme scenar-
ios, each with different prices and credit periods.
The special offer s ¼ 1; involves both new price
and credit terms, different from those of the
regular policy. The other two possibilities men-
tioned earlier ðp1 ; t0 Þ and ðp0 ; t1 Þ; alter only one of
the incentives, be it price or credit, respectively.
For comparability purposes both are listed in
Table 1, but neither is considered any further,
since they are both encompassed in ðp1 ; t1 Þ: In any
case, the demand for the retailer’s product depends
upon the type of offer ðps ; ts Þ; made to its own
156 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
customer base, as follows. Let Rs ðps ; ts Þ be the
retailer’s demand for scenario s: Then,
Rs ðps ; ts Þ ¼ apbs tes ;
for s ¼ 0; 1 and a > 0; bp0; eX0:
The power demand function in (1) uses the
standard constant-elasticity functional form ad-
vocated for this type of analysis, as it follows the
basic tenets of microeconomic theory (e.g. Arcelus
and Srinivasan, 1987).
Furthermore, in modelling the profitability of
the offers, the timing of the cash flows may not
coincide with the time at which the corresponding
costs and/or revenues are incurred, since a credit
period is one of the options. To resolve this
problem, the model does not attempt to match
revenues with costs. Instead, it uses an equivalent
procedure, used elsewhere for related situations
(e.g. Arcelus and Srinivasan, 1995b) and defined
by the third property.
Property 2.3. All cash inflows are assumed to be
immediately invested at the rate of r per dollar per
year and all outflows represent cash borrowed at a
rate of i per dollar per year.
It should be emphasized that Property 2.3 is
used only to handle the timing mismatch between
cost/revenues and cash flows. Obviously, an inflow
is reinvested not because it is an inflow, but
because, when it occurs, there is a liquidity excess.
Likewise, an outflow is financed not because it is
an outflow, but because at that time there is a
liquidity need. Nevertheless, it can be readily seen
that, when the revenue/costs match the inflows/
outflows, then both approaches yield identical
results.
2.2. The regular offer
The day-to-day vendor/buyer interaction with-
out any special trade or retail promotions results,
from the retailer’s perspective, in the following
policy:
Property 2.4. The retailer’s regular ordering policy
calls for purchasing orders of size Q0 , on a
vendor’s offer of ðc0 ; g0 Þ and an ordering cost of
$K per order, in order to satisfy a yearly demand
of R0 units, sold at a unit price of $p0 per unit,
with payment due after a credit period of length t0 ,
ð1Þ for a yearly profit of B0 :
It should be observed that the vendor’s trade
credit promotion of Property 2.4 is but one, albeit
widely used in practice, of the many possible
characterizations of the regular policy. Other
examples from practical situations include no
credit at all or standard trade credit terms, such
as the (2/10, n=30), i.e. a discount of 2% if paid
within 10 days or the entire amount is due within
30 days from the purchase date. The no-credit case
is covered when g0 ¼ 0: The other can be easily
incorporated into the model, as has been done
for related cases (e.g. Arcelus and Srinivasan,
1995b).
To derive the profit function for the regular
policy of Property 2.4, observe that B0 is simply
the difference between the per-cycle inflows, I0 ;
from the retailer’s ðp0 ; t0 Þ offer and the per-cycle
outflows, O0 ; arising from the vendor’s offer, times
the number of cycles, R0 =Q0 per year (¼ 1=Z0 ; the
inverse of the per-cycle depletion time). As shown
in Table 1, I0 is computed as the sum of two
components: (i) the revenue inflows, p0 Q0 ; from
the sale of the Q0 units demanded in each ordering
cycle; plus (ii) the interest earned at the yearly rate
of rð1  t0 Þ or rð1  t0 ÞZ0 per cycle on the average
uniform stream of revenue flows, p0 Q0 =2; arriving
during the per-cycle depletion time of length Z0 ¼
Q0 =R0 : Similarly, the expression for O0 reflects
(i) each cycle’s purchasing, c0 Q0 ; and fixed
ordering costs, K; plus (ii) the interest outflows
of the funds borrowed at the yearly rate of
rð1  g0 Þ or rð1  g0 ÞZ0 per cycle to pay for these
purchases. The end result is given by the following
expression:
B0 ¼ ðI0  O0 Þ=Z0 ¼ ðp0  c0 ÞR0  KR0 =Q0
þ Q0 ½p0 rð1  t0 Þ=2  c0 ið1  g0 Þ ð2Þ
with R0 as defined in (1). It should be observed
that the price/credit characterization of B0 ; as
given in (2) has not heretofore been treated in the
literature. The formulation is based upon the
 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
price-dependent demand model of Arcelus and
Srinivasan (1987), to which the credit incentive has
been added. As a result inventory is evaluated as
any other asset in terms of its profit-making
capability. Thus, the interest inflows from these
assets [first term in brackets from (2)] are
computed on the basis of their market value, p0
per unit, rather than at cost (Arcelus and
Srinivasan, 1989).
2.3. The special offer
The special offer covers the depletion time of the
retailer’s special order, placed in response to the
vendor’s one-time-only promotion. Hence, an
evaluation period large enough to encompass such
time span for all possible trade promotions is
needed to compare the profitability of the various
options. Such period, hitherto referred to as
the ‘‘planning horizon’’, gives rise to the next
property.
Property 2.5. The length of the planning horizon
is 1 year.
Note that the 1-year length has been made to
correspond to the usual definition of the rate
variables. In the unlikely event that a longer period
is needed, these variables can be redefined accord-
ingly. One consequence of using a common
planning horizon for all possible alternatives is
that, from the retailer’s perspective, the profit-
ability of each trade promotion is going to include,
in addition to that of the special period, another
component to account for the ‘‘regular’’ period
within which the vendor’s extraordinary offer is
not valid. Such period starts at the end of the
special period and covers up to the end of the
planning horizon. In such cases, the retailer must
resort back to its pre-special-promotion regular
ordering policies.
Property 2.6. The beginning of the planning
horizon coincides with a regular reordering point.
Observe that this property is made for exposi-
tory convenience. Extending the models of this
paper to cover the various starting points of
157
Arcelus and Srinivasan (1995a) or Ardalan
(1991) is straightforward. The final element of
the model is the definition of the retailer’s ordering
strategy throughout the planning horizon, given
by the next property.
Property 2.7. A special order policy, s ¼ 1, char-
acterized by the vector ðQ1 ; q1 ; p1 ; t1 Þ contemplates
the following decisions on the part of the retailer:
(i) at the beginning of the planning horizon, place
an order of size Q1 , on the basis of the vendor’s
ðc1 ; g1 Þ offer; (ii) offer ðp1 ; t1 Þ for the sale of a
portion, Q1  q1 , of the Q1 units, during the
promotional period lasting the first ½ðQ1  q1 Þ=R1 
fraction of the planning horizon and ðp0 ; t0 Þ, for
the remaining q1 units, to last the non-promotional
period comprising the next ðq1 =R0 Þ fraction of the
planning horizon; and (iii) resume the regular
ordering policy of Property 2.4 afterwards.
Observe also that, in accordance to the market-
ing practices discussed earlier, the structure of the
policy defined in Property 2.7 allows the retailer, if
its profit-maximization objectives consider it con-
venient, (i) to pass on only a portion of the benefits
of the trade promotion to its own customers; and,
further, (ii) to pass on such portion of the benefits
not on the entire special purchase, but only on
ðQ1  q1 Þ of them and thus being able to sell the
remaining, q1 ; units at the regular price and credit
conditions for s ¼ 0:
The inflows, I1 ; and outflows, O1 ; associated
with the special order policies are obtained in a
manner similar to those for the regular policy. The
functional form for O1 is akin to that for its s ¼ 0
counterpart, since both depend upon the vendor’s
offer, which consists of the same elements, the pair
of ðc1 ; g1 Þ values characterizing each scenario. The
only differences are (i) both the revenues and the
investment inflows are divided into two groups,
rather than being a single expression to reflect the
retailer’s special price and/or credit promotion;
and (ii) the depletion time, Z1 ; which is a function
of the portion of the special purchase which
qualifies for the retailer’s discount. The inflows
take into consideration the nature of the retailer
promotion, as characterized by the respective
values of ðp1 ; t1 Þ: In addition, a third component
158 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162

is added to the special-order benefits to cover the following:

profits from Z1 to the end of the planning horizon B1 ðQ1 ; q1 ; p1 ; t0 Þ  B1 ðQ1 ; q1 ; p1 ; t1 Þo0
of 1 year, as given by Property 2.6. Using Naddor
(1966)’s assumption, the profit contribution of the or ðQ1  q1 Þ½1=R1 ðt0 Þ  1=R1 ðt1 Þ
regular policy to the retailer’s decision process is
estimated as a proportion ð1  Z1 Þ; of B0 in (1), f1  2c1 iQ1 =½p1 rðQ1 þ q1 Þgot1  t0 : ð4Þ
concordant to its time length within the planning In (4), it can be readily seen that, regardless of
horizon. Combining all three components, the the sign of the term in brackets of the second
benefit of each scenario to be maximized is given inequality’s LHS, there always exists a t1 at0 ;
by such that the inequality holds. A similar argument
B1 ¼ I1  O1 þ ð1  Z1 ÞB0 ; ð3Þ may be developed for the comparison between
ðQ1 ; p0 ; q1 ; t1 Þ and ðQ1 ; p1 ; q1 ; t1 Þ and hence the
where B0is the value of B0 which maximizes (2)
dominance of passing on at least a portion of the
and Z1 ; I1 and O1 ; as given in Table 1. The
special incentive package &.
decision variables are listed in Table 1. They
include the components of the retailer’s offer
which differ from the regular’s, i.e. p1 ; t1 ; plus
2.4. Managerial insights
the special order quantity, Q1 and that portion for
which no discount is passed on, q1 :
An examination of the optimality conditions
Implicit in the derivation of the model is the
reveals a very appealing economic interpretation,
assumption that the retailer’s optimal response
that clearly delineates the role of each decision
should include an incentive policy whereby at least
variable in decreasing/increasing the outflows/
part of the vendor’s price discount and/or
inflows of the benefits functions and hence in the
additional credit should be passed on to its
retailer’s decision process. It should be observed
own customers. Contrary to the situation in the
that these specific functional forms of the flow
constant demand case, this result can be readily
justified from an economic perspective, since the changes depend upon the power demand specifica-
tion in (1). However, the identification of the
retailer may manipulate the demand through the
various types of flows is general. These insights are
pricing/credit mechanism in response to the
discussed next.
vendor’s special incentive and thus be at least no
worse off than before. The following lemma
Property 2.8. First optimality condition (on Q1 ).
establishes such result.
Consider
Lemma 1. It is always beneficial for the retailer to B10 ðQ1 Þ ¼ 0
pass on to its own customers at least part of the p1 þ p1 rðQ1  q1 Þð1  t1 Þ=R1  B0 =R1
vendor’s financial incentives (discount and/or cred-
it) received in the special order. ¼ c1 þ c1 iZ1 ð1  g1 Þ
þ c1 iQ1 ð1  g1 Þ=R1 : ð5Þ
Proof. Assume first that the retailer does not Then, other things being equal,
choose to pass on any of the credit incentive to its
1. A one-unit increase in Q1 causes the following
own customers. Then, its optimal policy may be
direct increases in inflows:
described by the vector ðQ1 ; p1 ; q1 ; t0 Þ: Consider an
alternate strategy with ðQ1 ; p1 ; q1 ; t1 Þ; where t1 at0 (a) Extra sales receipts of $p1 , for the addi-
is not even optimal. The proof consists of showing tional unit sold.
the existence of at least one t1 at0 ; which yields a (b) Extra ‘‘reinvestment inflows’’ of $p1 rðQ1 
higher profit than the rejection alternative. q1 Þð1  t1 Þ=ð2R1 Þ from the invested revenue
Using (3), not passing the incentive implies the proceeds of the additional unit sold.
 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
2. A one-unit increase in Q1 causes the following
indirect changes in inflows:
(a) It increases the ‘‘reinvestment inflows’’ by
$p1 rðQ1  q1 Þð1  t1 Þ=ð2R1 Þ on the average
inventory, as a result of the increase of
1=R1 in the discounted depletion time
ðqZ1 =qQ1 ¼ 1=R1 Þ:
(b) It decreases inflows by B0 =R1 , from the
revenue foregone by the decrease of 1=R1
in the length of the post discount period
½qð1  Z1 Þ=qQ1 ¼ 1=R1 :
3. A one-unit increase in Q1 increases outflows as
follows:
(a) Directly from the acquisition of the extra
unit through (i) the extra purchasing cost of
$c1 ; and (ii) the extra holding costs of
c1 iZ1 ð1  g1 Þ incurred by the additional
unit purchased.
(b) Indirectly through the increase of 1=R1 in
the length of the special depletion time, Z1 ;
which causes an increase in the holding
costs of ciQ1 ð1  g1 Þ=R1 for the entire
special order.
Property 2.9. Second optimality condition (on q1 ).
Consider
B10 ðq1 Þ ¼ 0
ðp0  p1 Þ  p1 rðQ1  q1 Þð1  t1 Þ=R1
þ p0 rq1 ð1  t0 Þ=R0  B0 ð1=R0  1=R1 Þ
¼ c1 iZ1 ð1  g1 Þ
þ c1 iQ1 ð1  g1 Þð1=R0  1=R1 Þ:
Then, other things being equal:
1. A one-unit increase in q1 causes the following
direct changes in the inflows:
(a) An increase of $ðp0  p1 Þ in revenues due to
the switch in the selling price from the
discounted to the regular.
(b) A change in ‘‘reinvested inflows’’ of
½p0 rq1 ð1  t0 Þ=ð2R0 Þ  p1 rðQ1  q1 Þð1  t1 Þ=
ð2R1 Þ, due to the switch in the selling price
from the discounted to the regular.
159
2. A one-unit increase in q1 causes the following
indirect changes in inflows:
(a) A change in ‘‘reinvested inflows’’ of
½p0 rq1 ð1  t0 Þ=ð2R0 Þ  p1 rðQ1  q1 Þð1  t1 Þ=
ð2R1 Þ, due to an increase in length of the
discount period by ½1=R0  1=R1 ¼ qZ1 =
qq1 , during which 1=R1 represents the
decrease in that portion of Z1 where the
discount is passed on to the retailer’s
customers and 1=R0 , the increase in that
portion of Z1 where the discount period is
not passed on to the retailer’s customers.
(b) A decrease in inflows by B0 ð1=R1  1=R0 Þ
through the revenue foregone from the
decrease in length of the post discount
period by ½1=R1  1=R0 ¼ qð1  Z1 Þ=qq1 :
3. A one-unit increase in q1 causes an indirect
increase in outflows of ciQ1 ð1=R0  1=R1 Þ
through the increase in holding costs to the
entire order, caused by the increase in the
special depletion period.
Property 2.10. Third optimality condition (on p1 ).
Consider
B10 ðp1 Þ ¼ 0
ðQ1  q1 Þ þ rð1  t1 ÞðQ1  q1 Þ2 ð1  bÞ=
ð2R1 Þ þ bp1 ðQ1  q1 ÞB0 =R1
þ c1 Q1 ið1  g1 Þbp1 ðQ1  q1 Þ=R1 ¼ 0:
ð7Þ
Then, other things being equal:
1. A one-unit increase in p1 causes the following
direct increases in the inflows:
ð6Þ
(a) Extra revenues of $ðQ1  q1 Þ from the
discounted sale, due to the increase in the
selling price.
(b) Extra ‘‘reinvestment inflows’’ of rð1 
t1 ÞðQ1  q1 Þ2 =ð2R1 Þ on the entire sale, due
to the increase in the selling price.
2. A one-unit increase in p1 causes the following
indirect changes in inflows:
(a) An increase in inflows on the entire sale of
brð1  t1 ÞðQ1  q1 Þ2 =ð2R1 Þ, through an
160 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
increase in the length of the discounted
depletion period of qZ1 =qp1 ¼ bp1 ðQ1 
q1 Þ=R1 :
(b) An one-unit increase in p1 causes a decrease
in inflows of bp1 B0 ðQ1  q1 Þ=R1 , as a result
of a decrease in the length of the post-
discount period of qð1  Z1 Þ=qp1 :
3. An one-unit increase in p1 causes an indirect
decrease in outflows of c1 iQ1 ð1  t1 Þbp1 ðQ1 
q1 Þ=R1 through an increase in the holding costs
of the special order as a result of an increase of
qZ1 =qp1 in the length of the discounted deple-
tion period.
Property 2.11. Fourth optimality condition (on t1 ).
Consider
B10 ðt1 Þ ¼ 0
2
p1 rðQ1  q1 Þ =ð2R1 Þ
2
 p1 reðQ1  q1 Þ ð1  t1 Þ=ð2R1 t1 Þ
þ B0 et1 ðQ1  q1 Þ=R1
þ c1 iQ1 ð1  t1 Þet1 ðQ1  q1 Þ=R1 ¼ 0:
ð8Þ
Then, other things being equal, a one-unit
increase in t1 results in all indirect effects on the
flows, as follows:
1. A decrease in ‘‘reinvestment flows’’ on the
entire sale, due to the decrease in the non-credit
period and hence in the rate per year.
2. An increase in ‘‘reinvestment flows’’ on the
average investment, due to a decrease in the
discounted portion of the depletion period of
qZ1 =qt1 ¼ eðQ1  q1 Þ=ðt1 R1 Þ:
3. An increase in the post-discount revenues, as a
result of the increase in the length of the post
discount period of qZ1 =qt1 , caused by the
corresponding decrease in the depletion period.
4. A decrease in the holding costs for the special
order as a result of the decrease of qZ1 =qt1 in
the depletion period.
3. The perishable case
When perishability is included, the main mod-
ifications in the methodology to derive the expres-
sions for Bs arise out of (i) the need to distinguish
the amount sold by the retailer to its customers
from the larger order to be purchased from the
vendor; and out of (ii) the nature of the differential
equation which determines the level of inventory
on hand (see (10) below). The former (latter)
affects the inflows (outflows). The revised expres-
sions for Is and Os ; along with the corresponding
optimality conditions are the subject of this
section.
With respect to the first modification, let
Ts ½T0 ¼ 1=ðyZ0 Þ; s ¼ 0; 1; be the depletion time
of an order of size Qs ; and Ys ðY0 ¼ 0Þ; the length
of time within Zs during which the retailer does
not pass on the trade promotion. Then, the inflows
may be written as follows:
Is ¼ ps Rs ðTs  Ys Þ
þ p0 R0 Ys þ ps rRs ðTs þ Ys ÞðTs  Ys  ts Þ=2
þ p0 rR0 Ys ðYs  t0 Þ=2; for s ¼ 0; 1: ð9Þ
The second modification affects the outflows,
through changes in acquisition and inventory
holding costs. In addition to the inventory deple-
tion from sales, inventory is also reduced by
deterioration, assumed for simplicity to occur at a
constant rate, denoted by y: As a result, the rate of
change in inventory over time, dVs ðtÞ=dt; may be
written as
dVs ðtÞ=dt ¼ yV0 ðtÞ  R0 ; s ¼ 0; 0ptpT0
¼ yV1 ðtÞ  R1 ; s ¼ 1; 0ptpT1  Y1
¼ yV1 ðtÞ  R0 ; s ¼ 1; T1  Y1 ptpT1
with Vs ðTs Þ ¼ 0 and Vs ð0Þ ¼ Qs ;
for s ¼ 0; 1: ð10Þ
From (10), the inventory level at time t may be
expressed as
Vs ðtÞ ¼ ðR0 =yÞfexp½yðT0  tÞ  1g; s ¼ 0; 0ptpT0
¼ ðR1 =yÞfexp½yðT1  Y1  tÞ  1g
þ ðR0 =yÞ½expðyY1 Þ  1 exp½yðT1  Y1  tÞ;
s ¼ 1; 0ptpT1  Y1
¼ ðR0 =yÞfexp½yðT1  tÞ  1g;
s ¼ 1; T1  Y1 ptpT1 : ð11Þ
 F.J. Arcelus et al. / Int. J. Production Economics 81–82 (2003) 153–162
Using (10), the retailer’s order size, Qs ; s ¼ 0; 1;
is given by
Qs ¼ Vs ð0Þ ¼ ðRs =yÞfexp½yðTs  Ys Þ  1g
þ ðR0 =yÞ½expðyYs Þ  1
exp½yðTs  Ys Þ; s ¼ 0; 1: ð12Þ
From (12), the cumulative inventory, Ss ; s ¼
0; 1; is given by
Z Ts Ys
Ss ¼ ðRs =yÞ fexp½yðTs  Ys  tÞ  1g dt
0 information to numerically determine the relative
Z Ts
þ ðR0 =yÞ fexp½yðTs  tÞ  1g dt
Ts Ys
2 payment reduction modes will enrich the gamut
¼ ðRs =y Þfexp½yðTs  Ys Þ  yðTs  Ys Þ  1g
þ ðR0 =y2 Þ½expðyYs Þ  yYs  1; s ¼ 0; 1:
ð13Þ
Based on (10)–(13), the outflows, Os ; s ¼ 0; 1 for
the perishable case are computed as the sum of the
acquisition and the inventory holding costs, i.e.
Os ¼ c0 Q0 þ KR0 =Q0 þ c0 iS0 ; for s ¼ 0
¼ c1 Q1 þ K þ c1 iS1 ; for s ¼ 1: ð14Þ
The retailer’s objective for the perishable case is
similar to that for its non-perishable counterpart.
The expressions for Bs given in (3) for s ¼ 1 and in
the first equality of (2) for s ¼ 0 are also applicable
here, with the appropriate expressions for the
flows from (9) and (14). Similar economic inter-
pretations to those in Properties 2.8–2.11 may also
be derived.
4. Some concluding comments
This paper has contributed to the generalization
of the special-sales problem, by considering pay-
ment reduction schemes other than temporary
price discounts. The model has also incorporated
other practical concerns, most notably a price-
dependent demand, in tune also to the current
tenets of microeconomic theory. As a result, the
retailer has the flexibility to modify its own selling
policies to better respond to competitive pressures,
by suitably modifying the portion of the special
order that is to be sold at a discount, as well as the
size of the discount that is to be passed on to the
161
ultimate customer. The paper has also identified
the sources of added profitability, when con-
fronted with possible fluctuations in the optimal
value of the decision variables. The managerial
implications of these results are clear and provide
a suitable framework to assess the relative profit-
ability of various payment reduction schemes.
Suggestions for further research abound. On the
empirical side, estimation of the demand and
deterioration functions will provide the needed
importance of the various policies the retailer may
wish to evaluate. The incorporation of other
of schemes available, while enhancing the rather
scant knowledge existing today with respect to the
evaluation methodology and the magnitude of
these trade-offs. The study of these and other
issues justifies additional research.
Acknowledgements
Financial assistance to the authors for the
completion of this research from the Natural
Sciences and Engineering Research Council of
Canada is gratefully acknowledged.
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